Housing Cycle Gets a Makeover
Around mid-Spring last year, “the lights went on” in the residential land acquisition game. Right now, the best that can be said for those lights is that they’re flickering and, well, dimmer.
“We’re looking at some new land offerings, and you’re definitely not seeing the bidders you were a few months ago,” says the CEO of one of the national public home builders. “For someone who’s an aggressive player looking for land, it’s defnitely a different game than it had been.”
Word out in the residential heartlands is that as many land deals have builders “backing out” as wanting in to the dance. The back outs–even in California, and even among a couple of the most aggressive home builders–D.R. Horton and KB Home–who’d been somewhat ravenous bidders until say, around April 30–leave the bidding to fewer, more careful players, which means prices don’t go soaring. Sometimes they even soften.
Some big players’ appetite for land is yet unsatisfied. There continues to be pressure among a number of big public builders to reduce conspicuous SG&A costs by opening new communities in a number of markets, and they’ve still got a passel of cash from Net Operating Loss tax carryback refunds to plow into lots for these new stores. Justifying a geographical footprint is motivation enough for continued interest in strong land positions in selected markets. But not every finished lot in kingdom come.
Others have slowed or halted their lot binge, and need to focus now on working through the speculative inventory they brought online in hopes of huge sales success during the waning days of the home buyer tax credits. That didn’t happen.
In the 12 months from April 2009 forward, big builders committed hundreds of millions of cash to acquire new lots in a massive re-load of their pipeline. The math of the amounts they paid comes down to two bets, one on price and the other on timing. With the recent acquisitions, builders are banking on order rate increases at higher gross margins based on lowered costs, including on lots.
With the incipient recovery in limbo, some of those price and sales pace assumptions will get a stress test in the months ahead.
Attention of the mainstream press still focuses on a froth in the land demand market that may or may not be history, depending on whether or how much traction comes back into the new-home market at the end of summer and early fall.
Now, as some of the more vaunted land parcels are due soon to come in to the market pipeline, momentum in demand for land may be tricky indeed. Specifically, the veritable goldmine of Lehman Asset Management Company parcels in California, the Southwest and Florida that have been tied up in bankruptcy since Lehman’s Sept. 2008 Chapter 11 filing are said to be of critical interest among buyers.
With the new-home market in federal government support cold turkey, questions remain on both the price tag builders paid (i.e. did they pay low enough), and the predicted absorption rates to drive past breakeven to profitability. While builders’ troves of cash are impressive following a couple of years of not spending on land as well as their NOL refunds, at least a few of them have to balance the risk of spending too much of their cash and a couple more years of negative cash flow.
The notion of burn rates–which gained widespread attention during the dot com bust–may also apply to home building if housing’s cycle remains relatively feeble.
Residential land pricing, one of new-home building’s leading economic indicators, is now going sideways thanks to the growing ranks of builders who’ve exited the fray. Equity market analysts have their “head and shoulders” rally theory, so why not consider a similar land demand pattern emerging pre-recovery in housing?
For those who are still in the land-buying market, this is a positive, because with less counter-bidding for preferred locations, winners of the auction will likely be able to build and sell their strongest product lines faster and more profitably.
The narrative we’ve heard repeatedly that plots typical housing cycles goes like this. As housing reaches a trough in its cycle, evidence of an inflection inevitably occurs in the equity markets first. Equity stocks investors‘ behavior is regarded as predictive, factoring in whatever headwinds remain, and pointing ahead toward a fundamentals recovery, usually down the road by four calendar quarters or so.
Then emerges an increase sales volume, which, when transactions sustainably pick up, leads to an increase in housing starts. Then, later into the upward trajectory of the parabola, comes pricing power, which crescendos at some inevitable point, and that’s when equities predict the next downward cycle.
Fact is, this narrative has shaped itself around several variables and a single constant–you guessed it, home prices. They just didn’t ever fall, at least not nationally.
The housing cycle, as several generations of home builder developers have known it, may be getting its own extreme makeover.